As a small business owner, you might not think that your personal credit score is important. However, a good personal credit score is required is you want to secure low-cost funds to pursue business building strategies.
This article explores why small business owners need to maintain a strong personal credit profile and how to manage your numbers.
What is a Personal Credit Score?
Your personal credit score is a number that evaluates your creditworthiness based on credit history. Once you accept your first job or apply for a credit card, a personal credit profile is started with the three credit reporting agencies - Equifax, Experian and TransUnion. Eventually, this report becomes an indicator of your ability to pay back a debt. Credit scores range from 300 to 850. The higher the score, the more financially trustworthy a person is considered to be.
Personal Credit Score Calculation
There are five main factors evaluated when calculating a credit score:
Payment history - 35% Shows if obligations are paid on time
Total amount owed - 30% This takes into account the percentage of credit available vs. credit currently being used (Also known as credit utilization)
Length of credit history - 15% Longer credit histories are considered less risky, as there is more data to determine payment history.
Types of credit 10% Shows if a person has a mix of installment credit, such as car loans or mortgage loans, and revolving credit, such as credit cards.
New credit 10% Factors in how many new accounts have been applied for recently that resulted in credit inquiries and when the most recent account was opened.
Why is Your Personal Credit Score Important?
Your quality of life can be dramatically impacted by your personal credit score. Establishing credit responsibly is almost always required to reach financial goals. Healthy credit allows you to:
Purchase a home. You need good credit to get approved for a home mortgage (unless you can save up hundreds of thousands of dollars and buy a house for cash).
Rent a home. The first thing property owners want to know about a potential tenant is that they can make regular rent payments. Your credit score gives a good idea of how responsible you are with your financial obligations.
Get favorable insurance rates. Credit-based insurance scores rely on credit history as one factor to determine premiums for different lines of insurance like auto and home.
Receive an upgraded education. Student loans or financial aid is often part of the package when pursuing higher education.
Fund a small business. If unable to bootstrap (use personal funds), many entrepreneurs use credit cards or other loan products to start and help run a small business. If you have poor credit, it’s very difficult to secure low-cost funds. Funds with high interest rates and short payback terms can crunch your cash flow and do more harm than good.
Steps to Improve Your Personal Credit Score
The good news is that you personal credit report isn't set in stone. Your numbers can go up or down depending on the credit strategies you use. Here are steps you can take to improve your numbers.
1) Closely monitor your score. Order your credit report from each of the three reporting agencies linked above. If you determine that there is an error, work to get it quickly resolved.
2) Keep an eye on your credit usage. One major factor of your credit score is the revolving credit you have available versus how much you're actually using. The smaller that percentage is, the better it is for your credit rating. According to financial professionals, the optimum is 30% or lower. The best strategy here is to pay down your balances and keep your balances low. NerdWallet has more in-depth information on this topic: How Is My Credit Utilization Ratio Calculated?
3) Pay bills on time. Delinquent payments and collections have a major negative impact on a credit score. Set up automatic payments to make sure you’re never late. You’ll also avoid expensive late fees.
4) Don’t apply for or open new credit accounts. You do need a good credit mix but opening new accounts probably won’t improve your score and an inquiry could cause your numbers to drop.
5) Pay off debt instead of just moving it around. Forbes has an excellent article about paying off credit card debt here: The Fastest (And Slowest) Way To Pay Off Credit Card Debt
6) Don’t close unused cards. Closing credit cards can be a good idea in some cases, but it can also have a negative impact on your score. For more guidance on this strategy, read The Motley Fool article, Should I Close Unused Credit Cards?
7) Be patient. There’s no quick fix to raise your personal credit scores. Craft a plan to improve your personal credit scores and stick with it.
The Bottom Line
Does a business loan affect your credit score? SBA loans are the "gold standard" for a small business owner with low rates, long terms and low payments. In order to qualify, keep an eye on your personal credit and work to get it in the required range.